Blockchain and Asset-Backed Tokenization

By Nick Roquefort-Villeneuve, Global Marketing Director – Amalto Technologies

Amalto-Asset-Backed-Tokenization

Some say Blockchain is all about hype. Others like myself strongly believe that it is already a game changer in the B2B sphere. At the end of the day, why would organizations like IBM, Maersk and American Express, among others, have invested significant financial and human resources to develop large-scale Blockchain projects?

For anyone who develops decentralized B2B applications that involve the execution of transactions, Ethereum is the Blockchain network of choice. And the main reason lies in the effort Ethereum has placed on smart contracts, especially regarding their validation process. It indeed takes approximately fifteen seconds to mine one Ether (Ethereum’s native cryptocurrency) whereas it takes over four hours to mine one Bitcoin; mining being the process required to validate a transaction on a Blockchain network.

Now, whether AMEX intends to run its upcoming decentralized applications on a proprietary Blockchain network that runs on top of Ethereum is not that important. However, it’s certain the company has understood the benefits Blockchain brings to trade finance. On a more global level, 80 to 90 percent of world trade relies on trade finance, and should you be surprised to read that paper documents still make up much of the information flow for trade finance…?

So, how can Blockchain benefit trade finance? Asset-backed tokenization is a major benefit.

Asset-Backed Tokenization

Asset-backed tokenization is “the process of converting rights to an asset into a digital token on a Blockchain.” Alright, what does that truly mean?

There are assets such as stocks, real-estate and commodities, which are difficult to physically transfer, subdivide and/or track. As a result, buyers and sellers trade series of paper that reflect the (successive changes in) ownership of some or all of the asset. In other cases, like commodity exchanges, electronic transactions and standardized agreements have replaced physical paper some time ago already, however those systems are colossal, and their proper functioning tends to generally rely on trusted participants. Blockchain can bring a solution to this tedious process by recording any changes in real-time and for all stakeholders to see, thus creating transparency and trust. Electronic traceability becomes a reality, which ultimately eliminates errors, confusion or even fraud. The characteristics of each asset along with their (fractional) ownership are stored in the Blockchain. Finally, and that’s where the term “tokenization” has its meaning, the Blockchain network’s native token is distributed to the asset’s owner as a representation of the existence of the physical asset. See it as a form of substitution, as receiving a token of ownership.

I could also take as an example a merchandise that was shipped and that needs to be tracked until it is delivered. How can one know whether it was damaged or held up along the way for whichever (unforeseen) reason? Trade documents move separately from the flow of merchandises, which often leads to situations when those shipments cannot be claimed by buyers until the title or other physical documents have been received. Naturally, those documents can be easily forged or manipulated. This increases the risk of document fraud for all trading parties involved. On a Blockchain network, the asset can be digitized through a token to identify who owns the merchandise, who currently has custody of it, and link the merchandise’s transfer among all trade transaction participants as the physical asset continues its journey until final delivery. Again, Blockchain brings transparence and visibility at all times for all stakeholders involved in the transaction. Paper-based documents as well as emails become useless, which prevents losses and other manipulations or fraud. A logistics dream.

Asset-backed tokenization can be applied to all forms of complex forms of trade finance. When my Executive Producer and I sold our documentary film to a European network in 2015, (pricy) lawyers needed to be involved to go through all the paperwork (in two languages) and the distribution of royalties according to our respective percentage of ownership. A Blockchain network would have streamlined the process. Since Blockchain is a peer-to-peer network, the TV network could have picked up the documentary digitally, which would have triggered and executed a smart contract whose code would have automated the payment of royalties based on each stakeholder’s ownership percentage, eliminating the intervention of an attorney in the process. The same model can easily apply to musicians. Thus, if music ownership were represented on a Blockchain network, all the participants in creating the music would have their shares set electronically. Furthermore, each time the song is requested on a Spotify or other Google Play, it would trigger an instant payment distributed to the appropriate holders. If we go one step further, ownership in a song could then be transferred to another entity as means of payment for another asset.

Barriers to Asset-Backed Tokenization

To tokenize assets certainly looks like a wonderful idea, however is there still a wide divide between concept and reality? The answer is undeniably yes, if the asset in question is “protected” by (heavy) regulation. A fact is that there is very little if no regulation whatsoever around Blockchain and cryptocurrencies. Let’s take a very simple example that perfectly reflects the situation: real-estate ownership. Local governments (counties) do not record deeds based on the outcome of the execution of smart contracts inside the Blockchain network in which they are participants, simply because today government at any level does not operate a Blockchain node. Regulation is such that real-estate deals must be processed by a third-party, in this case a residential or a commercial broker. Anyone who would tokenize the house he or she owns and sell it in exchange for cryptocurrencies would legally remain the rightful owner, whereas the buyer would be dispossessed of his or her cryptos and in no way protected by the law.

What system should be in place to assess and ensure the legitimacy of a participant to an asset-backed tokenization operation? Again, let’s use the real-estate example. Who’s telling me that the piece of property you pretend to own is truly in your name (deed recorded as such by your local county) and that there is no lien on the house, among other key-considerations? Today, those questions can only be answered by accessing information stored inside a centralized system, such as property tax records, etc. This process would indeed bring back a strong flavor of centralization, which is counter nature to the DNA of Blockchain technology: elimination of any intermediary, full on peer-to-peer environment. The question for which I have no answer just yet lies in the ability to include vetting data inside the chain for all stakeholders to access in full transparency.

Bottom-Line: Can I Tokenize My Mother-in-Law?

Blockchain connects all the dots together. And all parties concerned can see each dot. Virtually any physical asset can be tokenized, however regulation-induced barriers do exist, which prevent all the dots from being connected to one another. The challenge is to find ways that will bypass those challenges and strengthen the relationship of trust among all stakeholders that Blockchain technology innately provides.